When it comes to capital gains tax, the 50% CGT tax discount is a powerful tool. The knowledge that you can potentially enjoy half of your profits tax-free is common among Perth tax accountants and business families, but it’s also a key advantage that can significantly impact your financial decisions and how you go about tax structuring.
In this blog, we will discuss how to structure your affairs to enjoy the 50% CGT discount and what actions will prevent you from enjoying access to the capital gains tax discount – whether you are in Perth, Western Australia or Australia.
Explaining the 50% CGT discount: what you need to know
The 50% CGT discount is essential for anybody in Perth wanting to understand capital gains tax.
If you’re an Australian resident and sell an asset you’ve owned for more than a year, you could be eligible for a 50% reduction in capital gains tax. This tax concession also applies if the asset was acquired through inheritance or because of a relationship dissolution. The period of previous ownership may contribute to the 12-month threshold required for this discount, making it crucial to understand the eligibility criteria.
The original rationale behind the 50% CGT Discount?
The 50% capital gains tax (CGT) discount, a significant milestone in Australian tax law, was introduced in 1999 by the Howard-Costello administration. This reform replaced the earlier indexing method, which adjusted the cost base of assets for inflation to calculate actual realised capital gains, shifting towards a more straightforward and efficient tax system. It was a significant part of tax reform.
The introduction of the 50% CGT discount was a strategic move to balance tax equity and efficiency. Despite ongoing debates advocating for a reduction in the discount to enhance tax equity, successive governments have taken minimal legislative action, highlighting the intricate considerations involved in tax policy.
The 50% Capital Gains Tax Discount in Australia is designed to tax capital at one point in time, specifically on the sale of the asset. This means that the growth in the asset is taxed at the end of the sale and not over the period. If the growth was taxed yearly, then the tax bracket on that capital growth would likely be lower than taxing everything all at once, providing a significant tax advantage.
Capital is taxed at one point, and the tax rates on capital tend to be higher as the income is “bunched” together—the 50% CGT discount attempts to remove the tax impact of bunching.
What is the benefit of the 50% CGT Discount?
The most significant advantages of the capital gains tax (CGT) discount are often realised by individuals who sell their assets after surpassing the 12-month holding period. This is particularly beneficial if they sell them at substantially higher prices than their purchase costs, as it can lead to significant tax savings.
Take, for instance, someone who purchases a property and enhances its value significantly through renovations within a year. If this property is sold much higher than the purchase price, the seller would benefit from the 50% CGT discount.
How to calculate the 50% CGT Discount
To calculate the 50% CGT Discount, start by determining the capital proceeds you received from the asset sale. Next, subtract your cost base, which includes the asset’s initial purchase price and any additional expenses related to acquiring and/or maintaining the asset. This purchase must have occurred more than a year ago to qualify for the discount.
Incidental acquisition costs might cover surveyor fees, stamp duty, or transfer costs. The Australian Taxation Office (ATO) provides a comprehensive list of these expenses.
Ownership costs may include rates and land taxes; however, these can only be added to the cost base if they are not otherwise deductible. The ATO uses the example of vacant land to illustrate situations where this applies.
If your capital proceeds exceed your cost base, you’ve made a capital gain; otherwise, you’ve incurred a capital loss. The CGT discount applies only to net capital gains, meaning you must offset any capital losses against your profits before the discount can be applied.
How to enjoy the 50% CGT discount
When it comes to claiming the 50% CGT discount, it’s crucial to get professional tax advice from your Perth tax accountant. They can guide you on the tax disclosure in your tax return, ensuring that you are correctly claiming the discount and meeting all the necessary requirements.
The tax disclosure needed is different for trusts, individuals, and superannuation funds. As a company cannot enjoy the 50% CGT discount, the tax return will not ask about this claim.
How to get more than the 50% CGT Discount
The vast complexity of tax law provides a wide array of tax exemptions. We have generated the most benefit for some clients by unusually combining two tax exemptions.
Selling a property utilised for affordable housing might qualify for an additional 10% reduction in capital gains tax (CGT) on top of the standard 50% CGT discount. This extra discount applies for any duration the property was used to provide affordable housing, provided the total time amounts to three years or more, whether continuous or cumulative.
When selling an asset, you could consider the small business capital gains tax exemptions or the scrip for scrip rollover exemption.
An example of how the 50% CGT Discount works
Sally from Perth buys an investment property for $400,000 and sells it for $700,000 after five years.
The capital proceeds from this transaction are $700,000, while her cost base, including the original purchase price, stamp duty, conveyancing fees, selling costs, and agent’s commission, totals $530,000.
So, Sally has a capital gain of $270,000 ($700k less $530k).
Since Sally has no other capital gains or losses and is an Australian resident, she can reduce her taxable capital gain by 50%, resulting in a net capital gain of $135,000. She will be taxed on this amount at her personal income tax rate.
Can you enjoy the 50% CGT Discount on Crypto?
Crypto is an asset like real estate for capital gains tax purposes. So, if you profit from the sale of crypto (similar to Sally’s), you will also qualify for the 50% capital gains tax discount.
50% CGT Discount and the main residence exemption
If you sell a family home as your main residence, you can also enjoy a tax exemption for the profits on the sale of the family home. However, you cannot enjoy the 50% CGT discount as your profits are already tax-free.
The 50% CGT Discount and International Taxation
If you are a non-resident of Australia for tax purposes and sell the asset after 8 May 2012, you cannot enjoy the 50% CGT Discount.
Newly created assets
If the contract selling the asset creates the asset at that time, you will not enjoy the 50% CGT Discount. The asset’s acquisition date is when it was sold – so it was not held for 12 months.
An example would be if you were paid a capital amount to sign a restrictive covenant.
Companies
Capital gains made in a company or trust capital gains distributed to a company cannot enjoy the 50% CGT discount.
Losing access to the 50% CGT discount is vital for people using it.
Superannuation funds
Superannuation funds, including SMSFs, do not enjoy the 50% CGT discount. Superannuation funds and SMSF enjoy a 33 1/3% CGT discount, recognising the already lower tax rate they pay.
Property developers
If you are a property developer, you will most likely purchase land to sell it again at a profit. In this case, the asset acquired is trading stock (like oranges at a supermarket).
The 50% capital gains tax discount is only available on asset sales. The sale of trading stock is income from ordinary business activities, so the discount does not cover it.
Wealthier families in business with significant property holdings often use considered tax advice to reduce the risk of their assets becoming trading stock.
SMSFs
A classic SMSF strategy for a family in business is to acquire property in an SMSF. Once the SMSF is converted to a pension phase, the property will most likely be sold tax-free.
So, the 50% CGT discount won’t apply as the income is already tax-free.
Capital losses
If you sold an asset at a loss, you cannot offset that loss against ordinary income. The loss is retained and can only be used later against profits from the sale of another asset (not necessarily the same asset).
The capital gains tax discount is calculated after you have recouped earlier tax losses. So, in the case of Sally, if she had prior year tax losses of $300k, she would enjoy no capital gains tax discount. The entire $270k of capital profits would be allocated against the earlier tax losses.
Sadly, some Perth tax accountants have attempted to claim the 50% CGT discount and then claim the remainder of the net taxable profit against the earlier tax losses.
Share buybacks
If you sell your shares back to the company that owns them, the sale proceeds are not the cash you enjoy from selling them. Depending on the company’s operations, the majority of the purchase price paid to acquire the shares is deemed a dividend by the company to the shareholders.
So, the CGT discount is only calculated on the deemed sale proceeds of your shares. As the ATO views that most of the sale proceeds are a franked dividend (with franking credits), the sale proceeds on a share buyback cannot be used to calculate the 50% CGT discount.
Liquidation
A liquidator’s distribution is rarely a final return on the disposal of your shares. Tax law treats many liquidators’ returns as a franked dividend to shareholders and is not eligible for the 50% capital gains tax discount.
Building allowance
If you are enjoying a tax deduction for the depreciation on the cost of a Perth rental property, the 50% CGT discount is affected. The property’s cost base is reduced by the amount of building depreciation you have claimed, so the 50% CGT discount is increased.
Summing up
The 50% CGT discount is a significant tax benefit offered to business families across Perth. And it is not a “tick and flick entitlement”. Given the massive tax benefits on offer, it is fair that the tax law discussing the benefit is considered long and complex. This is where Westcourt is a natural choice – with our commitment to only providing tax advice to business families, independence of tax advice, awarded tax knowledge and global depth – we are an obvious choice when it comes to tax structuring and tax compliance for your business and family office – so why not give us a call – we can uncover tax opportunities tailored for your family you might not have come across.
